In 2013, global markets were characterized by an outflow of emerging markets portfolios aimed at developed nations who wanted to strengthen their local currency. In previous years, developing countries have enjoyed low interest rates from developed markets. This event has led to an increase in the value of exports in emerging economies, as well as creating a greater demand in the domestic market. Unfortunately, 2014 might see an increase of such rates, affecting the cost of financing of Chilean business. This occurrence could further push commodity prices that have been victims of a lousy 2013. The MSCI Emerging Markets Index was down 5% for the year.
In 2014, Chile is possibly threatened by the repercussions of events that could arise in larger economies. The first risk is the volatility that may occur in the markets after the Federal Reserve decided to start tapering its bond-buying program to $75 billion a month starting in January. Nevertheless, the tapering could even benefit the Chilean economy, indicating a strengthening in global trade and a recovered United States. To sustain the rally, the U.S. needs to see strong earnings growth for the year ahead.
The second challenge that Chile may face would be a rise of new tensions in the Eurozone. However, recent economic data provide evidence that the European region is improving and has led investors back to the markets with easy money policies; the European stock market posted a 17% return for the year 2013. Morgan Stanley has stated that, "2014 should be the year when we find out whether we get 'wish fulfilment' or whether the region remains condemned to a long and hard slog."
The third threat to the Chilean economy would be a slower economic growth for the second largest economy of the world. China currently is Chile's largest trading partner by volume. China is also the largest copper consumer worldwide, accounting for nearly 40% of the global demand. Lower demand of copper from China could push metal prices even lower, affecting greatly the Chilean economy. In the past four decades, Chile has made a remarkable effort diversifying its economy apart from copper. In 1970, copper accounted for nearly 80% of all Chilean exports, and today it only amounts for 50%. Thus, falling prices of the metal, would drastically affect the mining industry. This would bring about a ripple effect across multiple sectors of the economy, including construction and other related services. Moreover, a stronger dollar could also push prices of commodities even lower.
The fall of copper in 2013 marked a deceleration in Chile's economy. Copper stands at USD3.342 a pound according to COMEX latest data. GDP growth in Chile will reduce in 2014 due to lower investment activity in the mining sector. Despite the slowdown, Chile's growth is greater than the estimated average for Latin America. According to the Central Bank of Chile, the economy will grow between 3.75% and 4.75%. The inflation target determined by the Central Bank of Chile is set to 3% for the next two years; currently the CPI stands around 3%. To protect the value of the Chilean Peso, inflation should remain stable and within the proposed range; One Dollar buys $532.90 Chilean Pesos according to the New York Times. Low inflation would also eventually boost employment growth and protect low income households from an increase in prices. Past November data shows unemployment rate for Chile at 5.7%.
The political scenario for Chile in 2014 will be affected by the new mandate of president Michelle Bachelet, who served as president for the 2006-10 term. Bachelet will take the initiative to implement a number of reforms, in order to redistribute and reduce income inequality. One of Bachelet's reforms indicates an increase of corporate tax from 20% to 25% within 4 years. Bachelet also plans to remove the so-called Taxable Profits Fund, which gives companies permission to defer domestic tax payments. The education reform will also play a major role under this administration as she based much of her electoral campaign on this premise. Chile will invest about 5% of GDP on education, an increase of 33% from previous year.
One detail that has alienated many investors from Latin America and the Caribbean is the level of corruption and political instability of the region. In recent years, the Chilean government has taken measures to improve the management of public funds and increase transparency. Both rating agencies, Moody's and Standard & Poor's, placed a high grade in the nation sovereign credit: Aa3 and AA-, respectively. Chile is one of the best governed nations and has the best sovereign credit in Latin America and the Caribbean.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.